The Dollar Tanks on WSJ’s Fed Story

The U.S. dollar took a hit earlier today after the WSJ came out with a story about a policy that the Federal Reserve is considering. Let’s take a closer look at the story and try to piece together what’s going on behind the scenes.

The story is by Jon Hilsenrath and it begins:

Federal Reserve officials are considering a new type of bond-buying program designed to subdue worries about future inflation if they decide to take new steps to boost the economy in the months ahead.

So obviously someone big inside the Fed is chatting with Hilsenrath, and we can safely assume that the inside info has the approval of Bernanke himself. In fact, Ben could be the source; “Federal Reserve officials” is pretty vague. The info isn’t the kind of inside bickering you’d find if it weren’t approved. It’s just straight policy.

Under the new approach, the Fed would print new money to buy long-term mortgage or Treasury bonds but effectively tie up that money by borrowing it back for short periods at low rates.

This second sentence tell us what they’re thinking but now let’s look at the “why.”

The aim of such an approach would be to relieve anxieties that money printing could fuel inflation later, a fear widely expressed by critics of the Fed’s previous efforts to aid the recovery.

This is interesting because the Fed is acting in public to take on its critics. The next question a critical reader must ask is: “Why is this coming out now?”

Fed officials are set to meet next week and have signaled that they are unlikely to launch new programs at that meeting.

Bingo. So nothing’s on the agenda, but the Fed doesn’t want people to think that nothing is being considered.

Moreover, it is far from certain the Fed will launch another program later on. If growth or inflation pick up much, officials seem unlikely to launch a bond-buying program because the economy might not need the extra help or because doing more could spur higher inflation. But if growth disappoints or inflation slows substantially, Fed officials might at some point decide to act again.

Classic both sides of the argument. After that, Hilsenrath probably didn’t get any more from his source at the Fed. In the article, he turns to quoting Michael Feroli, an economist with J.P Morgan Chase.

This all sounds like a trial balloon sent by the Fed. This is very well played by the central bank. The Fed seems to be covering itself from its critics while not really committing itself to do anything.

The closest the Fed has come to QE3 is its Operation Twist which will be winding down at the middle of this year. There’s a slight chance the Fed will prolong it until the end of this year. However, if the Friday jobs report is a doozy, that would be a massive game-changer. The next concern would be a revival of inflation, and the Fed could reasonably claim that it has a strategy.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

Named by CNN/Money as the best buy-and-hold blogger, Eddy Elfenbein is the editor of Crossing Wall Street. His free Buy List has beaten the S&P 500 seven times in the last eight years. (more)